Europe Breathes a Sigh of Relief Over Greece

Greece gets second bailout as Europe contains the financial damage.

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Just weeks ago, the world was wringing its hands over the possibility of Greece dragging down the euro zone. To hear the talk now, the outlook is much improved--even sunny.

Speaking to reporters in Rome this week, Angela Merkel struck a hopeful tone. "We've come a good way along the mountain path, but we're not completely over the mountain," she said. Meanwhile, ratings agency Fitch has boosted Greece's sovereign credit rating from C to a B-minus--still indicating a default risk, but nevertheless an improvement.

[See pictures of Greek protests against austerity.]

And in a statement released after the Federal Reserve's Open Market Committee meeting on Tuesday, committee members subtly hinted at an improving European situation, noting that "Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook." The Federal Reserve chooses its words carefully, and in January's statement, there had been no such commentary.

Is the threat really that far diminished? In a word, yes.

"It looks, I would say that since late December, like things in Europe have gone as best as could have been hoped," says Craig Alexander, chief economist at TD Bank Group.

Europe is by no means out of the woods of economic crisis, but the recent developments seems to indicate that, while Greece is still headed for prolonged fiscal and macroeconomic problems, the rest of Europe no longer looks as likely to follow suit.

One reason for the improvement is the move by the European Central Bank, beginning in December, to make low-cost loans to European banks. That provided the banks with plenty of liquidity to continue operating and lending.

"I think the ECB's long-term refinancing operation...has done a lot to stem the risk of a catastrophic event in the European financial community, at least for now," says Mark Luschini, chief investment strategist at investment strategy group Janney Montgomery Scott.

[Opinion: America Needs Leaders Like Greece's Papademos or Italy's Monti.]

Keeping banks well-capitalized, says Luschini, has helped avoid an event like the Lehman Brothers collapse, which helped to kick off the U.S. financial crisis.

According to Alexander, the restored liquidity for European banks was the ECB's way of saying, "We're going to ensure that no European bank will fail while governments solve their fiscal problems." Bolstering banks while the nation heals from its economic problems mirrors the approach taken by the United States and its central bank, the Federal Reserve, after the U.S. financial crisis.

Greece last week took another large step toward trying to stem its fiscal problems, when its private creditors, a group that includes Greece's largest banks and other private investors, agreed to write off more than half of what they are owed, allowing the country to eliminate $137 billion in debt. That led to a second deal, approved by the Greek cabinet today, whereby euro zone members agreed to a nearly $170-billion bailout for Greece.

Luschini thinks this is an excellent sign: "With at least Greece having done the right things to get itself a second bailout, we now know that the most acute phase of the prospects of a disorderly default for Greece have passed." Such a default could have cost the euro zone more than $1 trillion, according to one estimate.

Still, it may not be enough. Alexander says that more restructuring and economic decline are still likely. The Greek economy declined at a rate of 7 percent in the fourth quarter of 2011, and heavy austerity measures could cause that contraction to continue--meaning that, even if the country continues spending cutbacks, its debt-to-GDP ratio may continue to grow.

The prognosis is not promising: "I think there's a high probability that Greece will ultimtely have to leave the euro zone," adds Alexander.

However, Greece's shaky future now looks increasingly likely to remain Greece's alone, with European banks looking more stable and fellow euro nations improving. Italy, once perceived as one of the largest threats to euro zone stability, successfully sold $7.8 billion in government bonds on Wednesday, a sign of renewed investor confidence.